Fed Trims Rates 1/4 Point, Disappointing Investors

AP

Wednesday, 12 Dec 2007 | 2:45 AM ETThe Associated Press

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The Federal Reserve cut benchmark U.S. interest rates by a modest quarter-percentage point on Tuesday to help the U.S. economy withstand tightened credit and a prolonged housing slump, disappointing Wall Street, which had hoped for more-aggressive action.

The central bank's decision takes the bellwether federal funds rate, which governs overnight lending between banks, down to 4.25 percent. While the action was widely expected, some economists had thought the Fed might offer a bolder half-point reduction in the rate.

"This was not what the market was looking for and did not move to clarify Fed intentions or assuage concerns of market participants of another leg down in the economy and resurgence of financial turmoil," said Joseph Brusuelas, chief U.S. economist of IDEAglobal in New York.

The Fed has now cut overnight rates, their key economic policy lever, by a full percentage point since mid-September in an effort to put a floor under an economy increasingly seen at risk of falling into recession. In a related move, the Fed trimmed the discount rate it charges for direct loans to banks by a matching quarter point to 4.75 percent.

"Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time," the Fed's policy-setting Federal Open Market Committee said in a statement outlining its decision.

The Fed noted that financial strains had increased in recent weeks and said some inflation risks remain. It refrained from offering its usual assessment of the balance of risks facing the economy.

"Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation," it said.

"I think we have a divided Fed, which is the problem" Bill Gross, head of the world's biggest bond fund, Pimco, said on CNBC immediately after the decision. "We have half of the Fed that gets it ...The other half doesn't get it. That portion is more academic--less connected to the financial market."

The Fed's decision follows renewed deterioration in credit markets after major financial institutions around the world reported billions of dollars worth of write-downs due to extensive exposure to delinquent mortgages.

Markets and policy-makers have been caught off guard by how hard and broadly rising defaults on U.S. subprime mortgages have hit. As roughly 1.8 million adjustable rate mortgages line up for reset at sharply higher interest rates in 2008, the prospect of more pain for homeowners and banks has loomed increasingly menacingly since the Fed last met in October and lowered the federal funds rate by a quarter point to 4.5 percent.

But the market could be misreading the Fed that today's quarter point rate cut represents the entire fed response to the credit crunch.

Breaking News

The Fed may use tools besides interest rates to address the liquidity crunch, with CNBC's Steve Liesman and the Fast Money crew.

A Fed source, told CNBC's Steve Liesman that the Fed still has under active consideration a set of tools to address the liquidity issue.

The source, who asked not to be named, would not say what those tools are, but Liesman's senses these ideas will see the light of the day sooner rather than later.

In the past, Fed sources have mentioned about the effort to come up with creative ways to address the liquidity crunch that did not necessarily use the fed funds rate. Ideas have included lowering the spread between the discount window and the funds rate, or long-term repo actions that put more cash into the market for a long period of time.

Clearly, other ideas are being discussed in addition to this. It's reasonable to assume that the Fed was less than happy and maybe a bit concerned with the market's reaction to the decision today. With the chief concern that today's action is the sole Fed response to the liquidity crunch.

With home prices sliding and borrowing conditions tightening, many forecasters are warning that the economy is skirting close to recession.

The No. 2 official at the International Monetary Fund said in an interview published on Tuesday that U.S. recession fears were overblown.

"Never say never, but the latest indicators do not justify such a conclusion," IMF First Deputy Managing Director John Lipsky told an internal IMF publication."